Fund Manager Noronha: Fed-Manipulated Rally Will Bring ‘Taxmageddon’

Hedge fund manager Pedro Noronha of Noster Capital says manipulations by the Federal Reserve have simultaneously caused a false market rally and set investors up for what he calls "taxmageddon."

"With Operation Twist, the Fed has effectively found a way to keep long term interest rates low-which reduces the discount rates that investors use to value future streams of cash flows, thereby increasing equities valuations-while at the same time managing to reduce commodity prices by not printing fresh new money," Noronha told CNBC.

"What this means is that the Fed has cleverly engineered another bull rally."

Not only have investors marked-up shares due to the present value increase of future cash flows, but the Fed has created an extra boost because companies are not facing the same headwinds from input cost inflation as commodity prices have fallen, according to Noronha.

“All it has done is push equity markets to unsustainable levels and once again saved the over-levered crowd from the fate they deserve,” says Noronha, who likens Fed policy to using aspirin to cure cancer.

“The U.S. will have to start dealing with issues that some market participants refer to as ‘Taxmageddon,’" says Noronha, an event that includes the expiration of the Bush tax cuts, the general payroll tax rate hike, the regular extenders, the reinstatement of estate tax and some of the tax hikes from Obama care.

“Conventional wisdom would have said that this will all be dealt with in a civilized manner because politicians wouldn't want to impose a 3 percent drag on an already-fragile and stimulated GDP,” Noronha says.

“We don't think this process will be anywhere near smooth and Mr. Market is drinking the Kool-Aid (once again), and completely ignoring the issues ahead of us.”

Bloomberg reports that the collapse in price swings of U.S. government debt to a four-year low shows increasing investor confidence that yields will stay at about record lows amid growing competition for a dwindling supply of the safest assets.

Not all economic experts have such a dire view of the nation’s future.

Barton Biggs, founder of the Traxis Partners LP hedge fund, said he isn’t adding to bearish equity bets in Europe after elections in France and Greece this weekend signal voters are seeking leaders who support more stimulus.

The U.S. economy is still strong and will avoid a double-dip recession while seeing a “soft patch” for the next month or two, Biggs told Bloomberg.

“The U.S. economy is still cranking along at 2.5 percent real gross domestic product growth,” he said. “That’s a good healthy level.”